Investing for life: A smart plan for paying for college

(CBS Moneywatch) If you have the means, you've probably been saving money to spend on your children's college educations. You've also probably been encouraging them save money.

Now that high school seniors are finding out about their college options, hefty tuition bills are just around the corner. This is a great time for families to sit down and do some financial planning. Here are some questions -- and answers -- to guide you as you start having these conversations.

What's the best way to tap savings to pay for college?

The answer to that question varies depending on your own family situations, but here are some general rules to consider:

Spend the student's money first. Most folks agree that students should have to contribute to the cost of their education. This also makes financial sense because since more of the student's assets are counted against financial aid awards, the sooner your student spends his or her money, the more financial aid your student could later receive. Also, if your student sells appreciated stock or mutual fund shares, she may pay capital gains tax at a lower tax rate. Thus, appreciated assets transferred to students goes further than the same amount of appreciated assets sold by a parent.

Next, spend down Education Savings Accounts. Money withdrawn from an ESA to pay qualified education expenses is tax-free. The money in an ESA is considered the child's assets and will count against you for financial aid, so if you might qualify for financial aid, then you'll want to spend this first.

Also, cash in any savings bonds you and your student may own. The interest rates on these are very low, so it's a good idea to spend this money and allow other investments to grow. Also, the earnings on savings bonds purchased after 1989 are tax-free when used to pay for education expenses.

So-called 529 education savings plans have become super popular and parents have amassed billions of dollars in these tax advantaged plans. Like the ESA, money withdrawn from 529s and used towards qualified education expenses is tax free. But use this after using other sources to allow this money to grow as long as possible before spending it.

Finally, spend any savings you may have accumulated in any non retirement accounts. Remember, if you have stock you intend to sell and use to finance college, gift that stock to your student instead. When he sells it to pay for college, he may pay a lower capital gains tax.

Avoid dipping into your 401(k) or other retirement plan to pay for college. Not only might you pay an early-withdrawal tax penalty, it may not be as easy as you think to replace these funds. Also, I advise against taking a loan from your 401(k) plan for your student's education. These loans typically need to be paid off when changing jobs. Unpaid 401(k) loan balances are treated as taxable withdrawals. Remember, you can obtain loans for college; you can't obtain loans for retirement.

How much cash will my student need?

Most students need about $3,000 to $5,000 in cash to get through the school year. They will need money for extras like books, a computer and printer, additional meals, laundry, cell phone, travel home, entertainment and sports fees. There are also unanticipated expenses such as a refrigerator, microwave oven, room furniture and the inevitable car repair, parking tickets or trips to the infirmary.

For these reasons, I advise parents and their kids to work up a college spending plan. List each category of expense and target a total amount they'll need for the year. If you won't be providing a monthly allowance, make sure they have a sense of how much money they will need to earn over the summer or in part-time jobs during school to fund their expenses.

What's the best checking account for students?

Even if they never write a check, students will still need a checking account. That's because these accounts provide for daily withdrawals from automatic tellers and for paying by debit card. The most frequent transaction by a student will be using their debit card and hitting up the ATM for cash.

Look for an account at the college credit union or local bank, to avoid the $1 to $3 transaction fees for using out of network ATMs. Title the account in the student's name. Avoid the overdraft credit, which only encourages spending money that isn't there and is sure to rack up more fees when used.

Parents who want to monitor their students spending can set up online access to their student's account and also request to receive duplicate statements. With online access, parents can even transfer money online to their students account on a scheduled basis or as needed.

At many colleges, the school issued identification card doubles as a smart card, which can be used for prepaid expenses such as meal plans and can also be linked to a local bank account and used as an ATM/debit card.

Students should keep the student ID separate from their bank account for two reasons: this keeps expenses covered by parents separate from the student's other spending money and reduces the risk losing access to the bank account when the student ID is lost or stolen.

Yes, your student will need a credit card

These are inevitable. Many students have more than one by the time they graduate. The main reason students give for applying for and using credit cards is a good one: to establish and build their credit. What they need to know is that this can backfire as too many credit cards and late payments can create a poor credit rating. This may not seem like a big deal until they get turned down for a car or home loan or, even worse, a job. Many employers check credit reports and turn down applicants who have poor credit ratings.

I advise parents never to sign jointly with their student on credit cards. This is an invitation to credit problems and identity theft when a student's wallet or purse is lost or stolen. Instead, set up a card with daily and lifetime limits for transactions. Parents who want to monitor their student's use of credit can receive duplicate statements or set up online access to view the account activity. Parents like this because they can see where the money is going.

What if my student needs a car at school?

When a student is taking a car off to school, I advise parents to transfer the title to the student's name, requiring them to register and insure it on their own. This protects the patent from liability and is also educational for the student. It's also a great idea to require the student to take two courses -- basic auto maintenance/repairs and safe driver education. These can pay for themselves many times over by avoiding common repair scams and reducing insurance premiums.

Do I need to buy my student health insurance?

Under the Affordable Care Act, a parent's health plan coverage will cover their student until age 26. Parents and students need to inquire how the student's medical coverage applies when away at school or abroad. They also need to know how the coverage works when using the college infirmary or out-of-network medical service providers.

I advise parents to make sure their student completes a Health Care Proxy and Living Will. These advance directives help to avoid making difficult decisions under duress. Although you can download the do-it-yourself forms online, I advise that parents arrange a meeting with their student and an attorney to do this. Also, students with assets should think about either jointly titling assets with their parents or getting a will.

An action plan for students and parents:

Raise money for tuition by spending your students' savings first

Create a monthly spending plan with your student

Open a checking account and debit card at a bank near the school with low (or no) fees

Help your student get a credit card, set spending limits and agree on monitoring

Review health insurance coverage

Review major expenses like a car and cell phone to look for ways to save